What is CFD? With 2 Practical Examples May 15, 2024
In this article, you will learn what CFD (Contract for Difference) is, the costs and benefits of trading CFDs, and two practical examples of trading CFDs in Singapore.
Meaning Of CFD
Source: Freepik.com
CFD stands for Contract for Difference. It is a derivative that allows traders to speculate on the price movements of an underlying asset, without actually owning the asset itself. CFDs are traded on margin, which means that traders only need to deposit a small amount of capital to open a position.
This makes CFD trading a relatively accessible way to trade the financial markets, even for those with limited capital.
Costs Of CFD Trading
Source: Freepik.com
When trading CFDs, there is a transaction cost, and a finance charge also known as a cost for holding a position overnight.
For example, assuming DBS is currently trading at S$30 and you want to buy 1000 shares. This means the total contract is valued at S$30,000.
Assuming the margin requirement is 10%, with commission at 0.1% with a minimum charge of S$15 and a finance charge of 6.75% you would have to pay the following:
On the other hand, if you were to trade using stocks, 1000 shares of DBS would require you to fork out S$30,000 cash, excluding commissions.
While you are still trading 1000 shares of DBS, you are using a higher amount of cash when trading stocks directly. There is an opportunity cost as the extra cash could be better utilised for other purposes.
Risks of CFD Trading
It is important to understand the risks involved before you start trading CFDs. CFDs are leveraged products, which means you can potentially lose more money than you have invested.
Additionally, you should be aware of the potential for market volatility, as it can cause CFD prices to fluctuate rapidly. Similarly, this applies to stocks as well.
Benefits of CFD Trading
Source: Freepik.com
Asset Exposure
Do you trade commodities, stocks, indices, ETFs, or forex?
You don’t have to choose. CFD trading gives you the same exposure to many different underlying asset classes, including the above!
Leverage
CFD trading also gives you leverage, which allows your money to work harder for you.
As mentioned in our DBS example, instead of laying down S$30,000 cash, you only need to lay down S$3,000 to start trading. This allows you to use the remaining S$27,000 for other purposes.
Lower Commissions
For certain products, the transaction cost can go as low as zero, with the only costs being the spread and overnight financing charges.
Who Should Do CFD Trading
If you have excess cash and you want it to work harder for you. CFD trading is the way to go.
CFD trading not only allows you to maximise your money’s potential, but it is also suitable for investors who want to take advantage of short-term price fluctuations.
CFD Trading – Buy Example
Source: tradingview.com
In Dec 2023 when a CFD trader buys 1000 shares of DBS at S$32 using CFD, he forks out S$3,200 instead of S$32,000.
As mentioned above, the commission charged is 0.1% of the contract value. The CFD trader pays a commission of S$32 (32,000 * 0.1%).
Assuming that the long financing charge for DBS is 6.75% and CFD trader holds the position over one night, the finance charge would be S$5.92 (32,000 * 6.75% / 365).
Over the next three days, the price goes up and the CFD trader liquidates his DBS CFD position on the 4th day at S$33. His commission for closing the position would be S$33 (33,000 * 0.1%).
In total, the CFD trader pays S$82.76 (S$32 + S$33 + 3 * S$5.92).
His profit would be S$33,000 – S$32,000 – S$82.76 = S$917.24.
His return on investment would be 28.7% (S$917.24 / S$3,200).
A stock trader, even with zero cost, would have a return on investment of 3.13% (S$1,000 / 32,000).
Here is a table for comparison:
CFD Trading – Shorting Example
Source: tradingview.com
Around early Aug 2023, UOB announced that it was going to give dividends and hence price was likely to adjust downwards, possibly even more.
On the dividend ex-date, the price gapped down and moved up, forming a bear flag.
This presented an opportunity for a CFD trader to short UOB using CFD. The trader could easily do so with the click of a finger, without any borrowing of shares or cumbersome paperwork.
Source: tradingview.com
Assuming the CFD does so, the trade would be executed at the price of about S$29.
In this scenario, the CFD trader pays S$29,000 * 0.1% = S$29 in commission.
Assuming that the short finance charge for UOB is 3% and the CFD trader holds the position over one night, the finance charge would be S$2.38 (S$29,000 * 3% / 365).
With reference to the chart, it only took 5 days for the UOB CFD to drop to S$28, and let’s assume the CFD trader closed the position on the 6th day.
For simplicity, we will also assume the overnight charge is the same for these 5 days.
His commission for closing the position would be S$28 (S$28,000 * 0.1%).
In total, the CFD trader pays S$68.9 (S$29 + S$28 + S$2.38*5).
His profit would be S$931.10 (S$29,000 – S$28,000 – S$68.90).
His return on investment would be 32.1% (S$931.10 / S$2,900).
Of course, if price moves against you, the absolute amount lost would be the same but losses would seem amplified as your cash outlay is lower.
A stock trader, even with zero cost, would have a return on investment of 3.45% (S$1000 / S$29,000).
Here’s a table for comparison:
Final Caution
It is important to choose a reputable broker that is regulated by the Monetary Authority of Singapore (MAS). PhillipCFD has been in operation for 20 years, with our parent company, PhillipCapital, having a history of almost half a century. At PhillipCFD, each account holder is assigned a designated dealer to provide the support you need.
Conclusion
It is important to know your objectives for trading CFDs. I have included two practical examples above and I hope you find value in them.
If you would like to learn more about CFDs, visit our website www.phillipcfd.com/learn.
If you do not have a POEMS account, you may visit here to open one with us today.
Lastly, trading within a community is much more enjoyable. You will get to interact with us and other seasoned investors who are generous in sharing their experience and expertise.
In this community, you will be exposed to quality educational materials, stock analysis to help you apply the concepts, insights into the mindset of seasoned investors, and even the opportunity to post questions.
We look forward to sharing more insights with you in our growing and enthusiastic Telegram community. Join us now!
For enquiries, please email us at cfd@phillip.com.sg.
Reference:
- [1] Freepik.com
- [2] Tradingview.com
Disclaimer
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CFD Disclaimer
Investments are subject to investment risks. The risk of loss in leveraged trading can be substantial. You may sustain losses in excess of your initial funds and may be called upon to deposit additional margin funds at short notice. If the required funds are not provided within the prescribed time, your positions may be liquidated. The resulting deficits in your account are subject to penalty charges. The value of investments denominated in foreign currencies may diminish or increase due to changes in the rates of exchange. You should also be aware of the commissions and finance costs involved in trading leveraged products. This product may not be suitable for clients whose investment objective is preservation of capital and/or whose risk tolerance is low. Clients are advised to understand the nature and risks involved in margin trading.
You may wish to obtain advice from a qualified financial adviser, pursuant to a separate engagement, before making a commitment to purchase any of the investment products mentioned herein. In the event that you choose not to obtain advice from a qualified financial adviser, you should assess and consider whether the investment product is suitable for you before proceeding to invest and we do not offer any advice in this regard unless mandated to do so by way of a separate engagement. You are advised to read the trading account Terms & Conditions and Risk Disclosure Statement (available online at https://www.poems.com.sg/) before trading in this product.
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This advertisement has not been reviewed by the Monetary Authority of Singapore.
This material is intended for general circulation only and does not take into account the specific investment objectives, financial situation or particular needs of any particular person. You should seek advice from a financial adviser regarding the suitability of the investment product, taking into account your specific investment objectives, financial situation or particular needs, before making a commitment to invest in such products.
About the author
Chua Minghan, CFA
Senior Manager, Dealing
Chua Minghan graduated from the National University of Singapore with a Bachelor’s degree in Economics. He is passionate about education and went on to get a post-grad Diploma in teaching. His vision is to educate clients to make informed decisions for their trading and investments.
Minghan enjoys learning fundamental analysis, technical analysis, and strives to use data analysis to improve his trading skills.
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